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Friday, 7 August 2015

﻿A few months back, we called the government’s Income Based Repayment plans, or IBR, “the student loan bubble’s dirty little secret.” As the name implies, the idea with IBR is that monthly student debt service payments are based on the borrower’s disposable income. The less money one makes, the less one has to pay. Each monthly installment under the program counts as a “qualifying payment”, and after 300 of these, the balance of the loan (assuming it’s not paid off after 25 years), is forgiven. Perhaps the most interesting thing about this scheme is that it allows for “payments” of zero. Here’s what we said back in April:

After 300 “qualifying monthly payments” — so after 25 years of payments — any remaining balance is forgiven and legally discharged. The interesting thing about this is that if the calculated payment is zero, it still counts as a “qualifying monthly payment.” That is, if, based on the borrower’s financial situation, he/she is not required to make an actual cash payment for a period, that period still counts towards the 300 “payments” needed to have the balance of the debt discharged, meaning that in the end, borrowers could end up paying substantially less than principal (taxpayers eat the balance) and are effectively allowed to remain in a perpetual state of default while avoiding actual payment default along the way.

Needless to say, when borrowers elect to enter an IBR plan, the payment streams from their loans become far more unpredictable, which is why suddenly, Moody’s and Fitch can’t figure out how to rate student loan-backed paper. The best (and most hilariously absurd) idea yet comes from Citi, who suggested last month that Moody’s should consider scrapping the whole idea of loan maturity, because after all, one can’t really default on a loan with an indeterminate maturity date so if you just amend the bond indentures and extend the legal maturity date to infinity, you don’t have to downgrade the ABS.

The proliferation of IBR causes other headaches, not the least of which is that it makes it even more difficult than it already was to calculate delinquency rates. To wit:

We, along with the St. Louis Fed, have argued that stripping out loans in forbearance or deferment from the delinquency calculations paints a clearer picture of where things actually stand because while you can argue about how those loans should be classified, what you cannot do is count those loans in the denominator but not in the numerator when calculating delinquency rates because if you do, you’re effectively ensuring that you will understate the true percentage of borrowers who are behind. As we’ve seen, the delinquency rate for borrowers in repayment is somewhere around 30%.

That said, if those who are enrolled in an IBR or PAYE program but whose financial circumstances are such that their calculated payments are zero are counted as both “in repayment” and as “current” (which seems likely), then even the 30% figure is likely a woeful misrepresentation of the actual delinquency rate, because those borrowers are being counted towards the total number of loans in repayment (the denominator) but not towards the total number of delinquencies (the numerator). Put differently: it seems rather strange to count someone as “current” just because their income-adjusted payment happens to be zero.

So as you can see, IBR presents quite a few problems for taxpayers, for ABS investors, and for anyone trying to get a read on just how perilous America’s $1.2 trillion student loan bubble is becoming. Realizing this, the media is beginning to take notice and Bloomberg now says taxpayers will likely be on the hook for around $39 billion. Here’s more:

Laura Strong, a 29-year-old in suburban Chicago, owes $245,000 on student loans for the psychology Ph.D. she finished in 2013. This year, she says she hopes to earn $35,000 working part-time jobs as a therapist and yoga teacher—not enough to manage a loan payment of about $2,000 a month. But Strong isn’t paying anything close to that. She’s one of at least 3.8 million Americans who’ve qualified for federal programs that tie payments to income and eventually forgive debt for some struggling borrowers, leaving taxpayers to pick up the tab.

President Obama has praised the programs for offering a lifeline to borrowers who’d otherwise default, scarring their credit. Strong pays about $100 a month on her federal loans, which she used to finance her graduate studies at Argosy University, a for-profit institution. “I wouldn’t know how I would pay it back otherwise,” she says.

Income-based repayment was introduced under President Clinton, but the programs weren’t heavily promoted until late 2013, when the Obama administration began sending e-mails to borrowers, including Strong, telling them, “Your initial payment could be as low as $0 a month.” The number of people using these plans has quadrupled since 2012.

And here’s a common sense look at why these plans put taxpayers on the hook:

The bottom line:

Borrowers hold $1.2 trillion in federal student loans, the second-biggest category of consumer debt, after mortgages. Of that, more than $200 billion is in plans with an income-based repayment option, according to the Department of Education and Moody’s Investors Service.For taxpayers the loans are “a slow-ticking time bomb,” says Stephen Stanley, a former Federal Reserve economist who’s now chief economist at Amherst Pierpont Securities in Stamford, Conn.

The Congressional Budget Office estimates that, for loans originated in 2015 or after, the programs will cost the government an additional $39 billion over the next decade.

So that’s a $39 billion taxpayer loss just on loans originated this year or later, and that could very well rise as schools begin to figure out that they can effectively charge whatever they want for tuition now that the government is set to pick up the tab for any balances borrowers can’t pay (which incidentally is precisely what we said in March).

Consider that, then consider how much of the existing $200 billion pile of IBR debt will have to be written off and add in another $10 billion or so to account for for-profit closures and it’s not at all unreasonable to suspect that taxpayers will ultimately get stuck with a bill on the order of $100 billion by the time it’s all said and done and that’s if they’re lucky – if the “cancel all student debt” crowd gets its way, the bill will run into the trillions.